Upon listing, IGB REIT will be Malaysia’s largest retail REIT with assets comprising The Gardens Mall and Mid Valley Megamall, jointly valued at RM4.6bn, and with a market cap of RM4.3bn and a potential free float of more than RM1.8bn. It offers a defensive dividend-yielding proposition and should trade at valuations comparable to the top three retail REITs, namely Sunway REIT, Pavilion REIT and CMMT, due to its sizeable retail exposure and asset quality. Our FV of RM1.37 is based on a sum of parts valuation, of which: i) 50% is derived from the average FY13f dividend yields of the top three retail REITs, at 5.1%, and ii) 50% from our estimated P/NAV of the top three retail REITs, offering a 9.6% upside to the IPO price.
The crown jewels. The entire issuance of 3,400m units of IGB REIT will be utilised to finance the acquisitions of its IGB Bhd’s two crown jewels, Mid Valley Megamall and The Gardens Mall, in addition to an estimated RM1,213m to be funded from the drawdown of a portion of IGB’s syndicated financing facilities. Both malls together will make IGB REIT the largest retail REIT listed in Malaysia, serving a large catchment of over six million people in the Klang Valley. Future developments around the vicinity as well as the expansion of the public transportation network, namely the MRT 2 Circle Line, will complement Mid Valley City's business by drawing in more shopper traffic.
Immediate boost from rental reversion. Both malls have solid track records in maintaining >99% occupancy rate and as high as a ~90% retention rate for the current year. We note that up to tenancy on 52.4% (based on occupied net lettable area) in The Gardens expire in FY13 while tenancy of as high as 36.6% in Mid Valley Megamall will expire in 2014. This will provide an opportunity for IGB REIT to renegotiate the rental terms and support its potential efforts to reallocate the tenant mix to sectors with higher rental margins. IGB REIT may see rate hikes potentially exceeding the conservative 5% forecast provided by the management.
Forecast yield at 5.0%, FV RM1.37. We believe IGB REIT should eventually be trading at valuations comparable to the sector’s top three - Sunway REIT, Pavilion REIT and CMMT - due to its enormous retail exposure and asset quality. Our FV for IGB REIT is RM1.37, based on a sum of parts valuation, of which: i) 50% is derived from the average FY13f dividend yields of the top three retail REITs of 5.1%, and ii) 50% based on our estimated P/NAV for the top three retail REITs. Our FV offers a 9.6% upside to the IPO price of RM1.25. The implied dividend yield based on our FV is 5.0%, which is fair compared to the other retail REITs’ 4.9%-5.1%.
IPO DETAILS
Main Market listing: IGB Real Estate Investment Trust (IGB REIT) is seeking to list on the Main Market of Bursa Malaysia with an offer for sale of 670m units by Mid Valley City Gardens SB, representing approximately 19.7% of IGB REIT's enlarged share capital of 3,400m units post-listing. Assuming a retail price of RM1.25 per unit, the REIT will be listed with a market capitalisation of RM4,250m.
KrisAssets to distribute 2.7bn units: IGB's 75%-owned subsidiary, KrisAssets, will distribute approximately 2.7bn units to IGB and shareholders after the IPO. KrisAssets has indicated that it will not maintain its listing status. This distribution exercise could potentially more than double the free float proportion of IGB REIT's share capital within a month of the listing.
The two crown jewels. The entire issuance of 3,400m units of IGB REIT's 3 issuance will be utilised to finance the acquisitions of IGB’s two crown jewels, Mid Valley Megamall and The Gardens Mall, in addition to an estimated RM1,213m to be funded from the drawdown of a portion of IGB’s syndicated financing facilities. Based on the indicative retail price of RM1.25 per unit, IGB Corp is expected to raise approximately RM837.5m in IPO proceeds, which will be retained for future acquisitions.
IGB REIT AT A GLANCE
Largest MREIT by retail size portfolio. Upon listing, IGB REIT will be Malaysia’s largest REIT with assets comprising The Gardens Mall and Mid Valley Megamall, valued at a combined RM4.6bn. In addition, IGB REIT will also own the largest value of retail assets, followed by other leading MREITs namely Pavilion REIT with a retail portfolio of RM3.4bn, Sunway REIT at RM3.1bn and CMMT at RM2.8bn. As we will elaborate in the later sections of this report, having a huge asset base allows IGB REIT to leverage on its borrowings for further property acquisitions without compromising its internal gearing and/or statutory limit. The expected market capitalisation of IGB REIT - at RM4.3bn - may qualify it as a participant in global equity indices such as the European Public Real Estate Association REIT Index, and in turn potentially trigger a re-rating of the REITs sector.
Retail-focused REIT managers with track record. IGB REIT Management SB, the REIT manager, will adopt an investment policy of having a diversified portfolio of income-generating real estate primarily used for retail purposes in Malaysia, overseas as well as other related assets. The REIT manager comprises a team with an established track record, spearheaded by Tan Sri Robert Tan Chung Meng, the Group Managing Director, who has over 20 years of experience in the property industry and holds directorships in Wah Seong Corporation and Tan & Tan Developments. He has been involved in various development projects since joining the IGB Group 1995. In particular, he has been instrumental in the success of Mid Valley City and its two prized shopping malls, as he was involved in all stages of their development projects since inception. Tan Sri Tan is also supported by his key management team with experience ranging from eight to 20 years in the relevant fields.
Tenancy agreement. The tenancy agreements for both malls are generally for two- or three-year terms, with the option for renewal upon the expiry of the term. A typical retail lease would be calculated based on the aggregate sum of the base rent or percentage rent (whichever is higher), and promotion charges. A typical indication of percentage rent would be one based on an agreed percentage of the tenants' monthly gross sales, while service and promotionl charges are payable by tenants on a per sq ft basis as a contribution towards a tenant's share of operating and marketing expenses.
RETAIL PROPERTIES
Mid Valley City. Mid Valley City is the result of IGB's masterplan offering a combination of retail, leisure, dining, entertainment and hospitality services. It is strategically located in a highly-populated area in KL City Centre and is one of the largest mixed-use developments in the Klang Valley, with an 50-acre site and built-up areas reaching 18m sq ft, developed since 1989. Mid Valley Megamall and The Gardens Mal, located adjacent to one another, form a significant retail offering for Mid Valley City. Both malls are supported by hospitality businesses, at least three four- and five-star hotels with 1,683 hotel rooms and serviced residences and average occupancy rates of at least 75%. There are also seven commercial office buildings covering 2.6m sq ft of net lettable areas (NLA) in Mid Valley City. Mid Valley City is accessible via five major road systems and has a bridge that connects to public transportation network stations namely LRT, KTM and the Monorail.
Mid Valley Megamall. Mid Valley Megamall is one of the largest malls in the Klang Valley. It is a five-level retail mall with two levels of basement car parks and four levels of elevated car parks. It has three anchor tenants, being Metrojaya, AEON and Carrefour, with other tenants including Harvey Norman and MPH. It also houses an 18-screen Cineplex, a bowling alley and an approximately 66,395 sq ft convention centre. When it first opened, Mid Valley Megamall was one of the country’s biggest malls with a large number of retail offerings as its greatest attraction for shoppers.
The Gardens Mall. The Gardens Mall is an eight-level retail mall supported by four levels of basement car park and four levels of elevated car park. It has 209 tenants (as at 31 May 2012), with a wide range of mid- to high-end luxury brand retail boutiques covering fashion, entertainment, health and beauty, electronics and dining services. Some of its major tenants include anchor department stores Robinsons from Singapore and Isetan from Japan, amongst the many international and local brands. It also houses spas, wellness clinics and a top-notch Cineplex GSC Signature. The mall was designed by architect Eric Kuhne with a local flora-and-fauna design to create a pleasant environment for shoppers and visitors through the use of local traditional arts and crafts.
INVESTMENT HIGHLIGHTS
Size matters. Upon listing, IGB REIT will emerge as the largest REIT in the country in terms of size in retail exposure, with a total asset size amounting to RM4.6bn. Its size will also help spur more international institutional and retail participation for the REITs sector in Malaysia, as in the past MREITs encountered liquidity problems and only a few have market capitalisation of over RM1bn. Subsequently, its large portfolio of assets will also enable the group to leverage on financing for further acquisitions, which will result in overall NAV accretion. Assuming a comfortable gearing level of 35% and total asset value of RM4.6bn, IGB REIT can borrow up to RM1.61bn for expansion purposes.
Potentially large free float within a month post-listing. KrisAssets plans to distribute the 2.73bn units arising from the IPO to IGB and retail and institutional investors, in order to fulfill the listing rules requiring public unitholders to hold at least 25.0% of the total units in issue. This distribution exercise is expected to more than double the public unitholding spread from approximately 14.8% to above 40%, excluding directors and selected investors. We think this potential large free float is a good sign of more liquidity and may imply a further premium for IGB REIT’s valuation relative to other MREITs. IGB is expected to hold 51.0% of the REIT. Please refer to Table 1 in the section "IPO Details" for the shareholding structure.
Strong retail exposure. Upon listing, IGB REIT will have the largest retail assets among the REITs listed in Malaysia. Mid Valley Megamall and The Gardens, adjacent to one another, constitute the largest inter-linked retail property site in Malaysia with a combined NLA of over 2.5m sq ft and total 662 retail outlets as at May 2012. CBRE Research reported 137 malls in the Klang Valley as of 2011, of which 59 malls are in KL. However less than 60% of those comprise performing malls, which are the actual dominant drivers in the market. This indicates a strong demand for performing malls within the region as the per capita retail space contributed by the performing malls in the Klang Valley is only at 4 sq ft, behind regional Bangkon’s 5.3 sq ft, Singapore’s 7.2 sq ft and Hong Kong’s 16.4 sq ft. The KL Eco City Retail Podium, a potential competitor to IGB REIT’s malls in terms of proximity, is expected to open in 2015 and hence, is not likely to pose a major threat in the near- to medium-term. Moreover, it is unlikely to expect openings of new premium fashion malls until 2015, with the exception of the extensions to Pavilion and Suria KLCC, which make a good case for The Gardens Mall as it is still at a relatively young stage in its business.
Catering to multi-segments. Each shopping mall is designed to target different markets segments. Mid Valley Megamall serves the mass market and families with its well-diversified tenant mix and is expected to continue to be a major recurring income driver. The Gardens Mall is one of the few premium fashion malls catering to an increasing population of high-income customers, expatriates and tourists. In the Klang Valley, only 7.7% of retail space is occupied by premium fashion malls, with the notable ones aside from The Gardens being Pavilion KL, Starhill Gallery and Suria KLCC.
Retail ithe defensive top pick this time around. We view that right now is a good time for IGB REIT's to list as the retail business' outlook is expected to remain buoyant, especially in the Klang Valley. According to Malaysia Retailers Association (MRA), retails sales growth is projected to be at 6% in 2012. This is comparatively more bullish than the neutral office sector outlook, which is under pressure due to oversupply, in view of the development of mega projects such as the Tun Razak Exchange, KL Metropolis and Warisan Merdeka.
Some details on revenue forecasts. Management has assumed a 5.0% increase p.a. in percentage rent for both megamalls. For base rent, tenancies are assumed to be renewed at a 5.0% increase for Mid Valley Megamall and 15.0% for The Gardens. Occupancy rates are projected to remain resilient at a >99% level, which is superior to that in average premium malls. Aside from rental, other incomes are expected to contribute the remaining 21% of total revenue for FY12 and FY13. The major components of other incomes consist of car park income, advertising and promotional (A&P) income, utilities recoverable, kiosk rent, other leasing income and miscellaneous income. Car park income is projected at a 5.0% growth based on historical levels and a raised car park season pass rate to 50% (both megamalls have a combined 10,220 car park lots). For A&P income and utilities recoverable, management has projected a 3.0% increase per annum.
Synergy factors. The IGB REIT's two shopping malls form part of Mid Valley City’s integrated master plan. The proximity of the hotels, office and mixed-use properties at Mid Valley City allow them to synergistically support one another to cater to a large population of visitors while maintaining the traction of shopper traffic throughout the peak and non-peak hours. In addition, Mid Valley City's status as a Multimedia Super Corridor Malaysia Cyber Center commercial precinct is expected to further enhance its appeal as a preferred destination for the corporate workforce, who in turn, will contribute to the retail businesses of both megamalls, especially the F&B segment.
Potentially sizeable rental rate hikes. Our trade sector analysis shows that tenants from fashion apparel and food and beverage (F&B) sectors contribute to the best rental margins. In Mid Valley Megamall, fashion apparel tenants took up 14.0% of total NLA and contributed up to 31.1% of gross rental income while those from F&B took up 11.6% of total NLA and brought in 17.8% of gross rental income. For The Gardens Mall, fashion apparel tenants took up 13.3% of NLA, contributing 23.5% of gross rental income, while the F&B sector took up 15.5% of NLA and contributed 18.8% of gross rental income. Management said it is comfortable with the current tenant mix but has not ruled out potential relocating efforts to garner a more lucrative share in those two sectors. If this happens, it will likely drive growth in the rental rates as the premium fashion brands can afford to pay steeper rents. Recently, it secured Uniqlo to take up the lettable area previously occupied by MPH Bookstores in Mid Valley Megamall. We think that The Gardens Mall has more room to grow its fashion tenant mix as more top-end luxury brands are expected to sign up for space. Note that the rental rate for Gardens Mall is significantly lower than Pavilion's at RM14 per sq ft, and the tenant mix occupancy for fashion apparel is also below Pavilion's mix at 26% of NLA.
Huge population catchment supported by transportation links. In addition to its size, IGB REIT’s properties are strategically located in central Kuala Lumpur to serve the Klang Valley’s large population. According to an independent property market consultant, the full catchment area encompasses over six million people as at 2010. Thanks to a convenient transportation network, Mid Valley City has an immediate catchment comprising affluent suburbs in the Klang Valley such as the upmarket Bangsar commercial and residential areas and the established Damansara Heights, Seputeh and Petaling Jaya residential area. Moving forward, management believes some upcoming mixed-use development projects around the vicinity, such as Bangsar South and KL Eco City as well as the expansion of the public transportation network namely the MRT 2 Circle Line, will complement Mid Valley City's business by further drawing in shopper traffic.
Healthy, flexible capital structure. Based on IGB REIT's pro forma balance sheet, it will have debts amounting to RM1,206m, translating to a debt to asset ratio of 25.8%, which falls below the average listed Malaysian REIT’s approximately 29.2% for FY11, and is significantly below the prescribed limit of 50.0% under the REIT Guidelines of the Securities Commission of Malaysia. IGB REIT's sheer asset size allows it to leverage on a large amount of financing for future acquisitions. Assuming a comfortable 35% gearing level, the group can borrow up to RM1,614.6m, or up to RM2,337m in financing, before breaching the 50% prescribed limit.
INVESTMENT RISKS
Tenancy cycles, a double-edged sword. IGB REIT's assets are subject to substantial levels of tenancy expirations in certain years. As much as 54.2% of the tenancies (based on occupied NLA) in The Gardens will expirein FY13 and as high as 36.6% of those in Mid Valley Megamall will expire in 2014. This could impact the properties' occupancy rates, and subsequently rental income, if there are no renewals of leases. However, we are not overly concerned as this risk factor could be a growth driver in disguise instead, especially if both malls are able to maintain good rental reversions for FY13 and FY14. Recall that their tenancies have lease terms of two to three years, and renewing tenants may see their rental rates increase by 5.0% for Mid Valley Megamall and 15.0% for The Gardens. Mid Valley Megamall has historically secured very healthy retention rates. The Gardens has just begun seeing the early cycles of rental reversion since its opening in 2007, whereby the first cycle occurred in FY10 and the next one is expected to occur in FY13. The fact that other major retail peers such as Sunway Pyramid and Pavilion are expected to see tenancy expiries of as high as 60% of NLA for FY13 may benefit IGB REIT’s malls i negotiating rental renewals. Moreover, the management has clarified that retention rates for The Gardens Mall have begun to normalise from the low levels prior to the first rental reversion cycle in FY10. It also expects to see retention rates approaching those of Mid Valley Megamall’s in time to come.
Little visibility for asset injections. Unlikeits major peers Sunway REIT, CMMT and Pavilion REIT, IGB does not have clear plans to inject assets into the REIT in the foreseeable future as its existing retail assets are concentrated in Mid Valley City. IGB does, however, have a land bank of 2,000 acres remaining in Selangor, with several notable assets catering to the offices and the hospitality sectors. The company has previously mentioned that it was considering allocating several billion ringgit for projects in Europe and the US, mainly in hotels. However, Tan Sri Tan has indicated that the group may unlock the values of the said assets in the form of separate office REITs and hospitality REITs and therefore the strictly 'retail assets concept' further limits the potential of it injecting assets into IGB REIT. Johor’s Southkey Mall is a clear project in IGB’s pipeline and has the potential to be injected into IGB REIT, but this is a very three- to five-year plan as the company only just recently signed the agreement for its development. IGB REIT does not rule out the possibility of acquiring assets from external parties locally or overseas, though this indicates that any acquisition drivers are limited to third party acquisitions of retail assets.
Sustaining shopper traffic. According to CBRE Research, about 80% of combined footfall from the two malls comprises visitors who travel by car; hence the availability of car park bays forms an essential part in the future growth of shopper traffic. There is evidence that the current car park usage may be reaching full capacity and given its average daily turnover of three turns per car park bay per day, the company is unlikely to see the number of existing car park bays expand from the existing 10,220 lots, which is considerably larger in developments akin to Mid Valley City. This situation turn around once a more efficient public network infrastructure kicks in, in the mid- to long-term.
Asset enhancement may be volatile. Generally, retail malls have to consistently revamp their infrastructure and appeal to visitor interests moving forward, and for retail REITs, any asset enhancement initiatives are positive for preserving asset quality. This is a more relevant issue for Mid Valley Megamall, which has been around for 10 years and may start to see some saturation in its appeal. Management has provided a forecast of capital expenditure for FY12 and FY13 at RM5m per year for Mid Valley Megamall and RM1.25m for The Gardens Mall for asset enhancement initiatives. However, we think the forecasts are too conservative and that the capital expenditure may have to be higher than expected, judging from the more aggressive asset enhancement initiatives being carried out by its major competitors, which are significantly higher than the combined RM6.25m.
VALUATIONS AND RECOMMENDATIONS
IPO price at a premium to sector. Based on the expected NAV/unit of RM0.99 upon listing, IGB REIT’s P/NAV is estimated about 1.25x assuming the retail price of RM1.25. This is at a 14% premium compared to the average level traded for all M-REITs but there is still some upside when compared to the top three retail REITs namely Pavilion REIT, Sunway REIT and CMMT which are trading at an average of 43% premium over NAV. We believe the yields compression for retail malls are likely to persist in the medium term as they are spurred by the influx of investor interest to dividend-yield features and the defensive nature of retail REITs, hence we think that IGB REIT should enjoy the same premium as well.
FV of RM1.37. Our FV for IGB REIT stands at RM1.37, based on a sum of parts valuation which are the i) 50% derivation from the average FY13f dividend yields of the top three retail REITs at 5.1%, and ii) 50% derivation from our estimated P/NAV of the top three retail REITs. Our FV offers a 9.6% upside to the IPO price of RM1.25. The implied dividend yield based on our FV is 5.0%, which is within the forecasts for the other top three retail REITs namely Sunway REIT, Pavilion REIT and CMMT, at 4.9%-5.1%.
SUBSCRIPTION, ANOTHER ANGLE : KRISASSETS vs IGB REIT
Cheaper bargain? Some investors may wonder if buying KrisAssets shares (KRIS MK, Non-Rated) may provide a cheaper alternative to gain access to IGB REIT's IPO. Recall that KrisAssets will undertake a distribution exercise of 2,730m IGB REIT units to IGB Corp and other shareholders after the listing. IGB Corp will see its shareholdings rise to 51% and the remainding 49% will be allocated for public and institutional shareholders. Thereafter KrisAssets will be voluntarily wound-up and de-listed by Bursa Securities. Based on the calculations extracted from KrisAssets' circular to shareholders, for every one share of KrisAssets owned by a shareholder, he/she would be entitled to 5.24x IGB REIT units and an estimated additional RM2.43 cash payment. Assuming KrisAssets’ closing price of RM9.15 as at 30 Aug 2012 and that the proposed cash payment is unchanged, the IGB REIT 'pricing' arrived at is RM1.28. Hence, it is cheaper to subscribe to the IGB REIT unit for a retail price of RM1.25. However, we think the run-up of KrisAssets’ share price could be attributed to a premium, as this is a more guaranteed method to obtain IGB REIT's shares as compared to an IPO subscription, albeit the time delay for the entitlement to materialize.
Source: OSK
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